The nagging feeling that something has changed became more than a feeling this week, and I'm not talking about the classic rock song by
Boston . Yes, the sneaking suspicion the postwar rally had run out of momentum, at least temporarily, became a reality this week as major averages fell uniformly. More dramatically, Treasury prices plummeted and yields jumped after the Federal Reserve's midweek decision to lower rates by 25 basis points. For the week, the Dow Jones Industrial Average fell 2.3%, the S&P 500 shed 1.9%, and the Nasdaq Composite lost 1.2%. The failure of Monday's merger announcement between Idec Pharmaceuticals ( IDPH) and Biogen ( BGEN) to rekindle strength in the biotech sector, much less the broader market, was a clear signal the rally's worm had turned. Also troublingly, from a technical perspective, both Wednesday and Friday were reversal days, whereby major averages established higher highs and lower lows than in the prior session. The pattern has more significance if there's an accompanying volume surge -- not the case in either instance -- but some believe the reversal days are emblematic of a market running into trouble. Included among them is Charles Biderman, president of TrimTabs.com Investment Research in Santa Rosa, Calif. At a luncheon at Moose's restaurant in San Francisco on Thursday afternoon, Biderman laid out the case for why he believes the market is exhibiting signs of a "classic top." The signs include heavy corporate selling, renewed optimism among individual investors (the American Association of Individual Investors this week reported that bullishness among its members rose to 71.4% while bearishness plunged to 8.6%), and the increased use of margin debt, including that used by corporations. General Motors ( GM) will use some of the proceeds of its record $17.6 billion corporate bond offering to replenish its pension fund, which very likely will invest much of that money in equities.
"The pain of those short right now could continue a while longer if more pension funds want to take full advantage of buying stocks at the top," Biderman commented. "However, when the run of borrowing to buy ends, the market will plunge hard and fast." Biderman, who turned bearish in late May after a bullish call on March 11, forecast the S&P will fall under 900 in the third quarter. "At that point, either there will be an economic recovery that will source corporate buying, or stocks might have to drop further before corporate buying puts a floor under the coming market decline."
Merely a Flesh Wound, or a Deeper Cut?To be sure, Biderman remains in the minority even though Chartcraft.com's Investors Intelligence survey showed bullish sentiment fell to 59.4% from 60.2% last week, while bearish sentiment rose to 17.7% from 16.1%. Thursday's pretty solid advance and the continued pattern of lower volume on down days -- which re-emerged during setbacks on Monday, Wednesday and Friday -- has many market participants convinced that this week will merely prove to be a temporary pause in the robust advance since the mid-March lows. Clearly, there were few signs of panic among buyers, and there was little broader market impact from warnings and/or disappointing guidance from firms such as Tenet Healthcare ( THC), Walgreen ( WAG), Avery Dennison ( AVY), FedEx ( FDX), Verity ( VRTY) and Nike ( NKE). Optimists focused on the better-than expected results from Goldman Sachs ( GS) and Bank of America's ( BAC) raised dividend. Meanwhile, Freddie Mac's ( FRE) huge earnings restatement provided fodder for both the bull and bear camps. The week's economic data were similarly a mixed bag. Consumer confidence fell but was stronger than expected. Meanwhile, existing-home sales surged to record levels, weekly jobless claims fell to a three-month low, and the University of Michigan consumer confidence index was revised upward. The Economic Cycle Research Institute's weekly leading index rose to 124.1 for the week ended June 20, from 123.4 the prior week, and the index's four-week moving average rose to 6.9% from 6.1%.
On the other hand, May durable goods orders unexpectedly fell 0.3%, first-quarter GDP was revised downward to 1.4%, and May personal spending rose a tepid 0.1%. The
statement accompanying the Fed's rate cut Wednesday reflected the data's mixed signals: "Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing," the Fed said. "The economy, nonetheless, has yet to exhibit sustainable growth." Although the central bank repeated its warning about the potential for "an unwelcome substantial fall in inflation," the Fed declared that the balance of risks facing the economy was "roughly equal" between upside and downside. That generated speculation this latest rate cut may be the last of the cycle , which sent Treasury prices reeling. For the week, the yield on the benchmark 10-year note rose 18 basis points to 3.54%, its highest level since May 13. After falling 12/32 to 100 23/32 on Friday, the price of the 10-year Treasury completed its worst two-week period since October, Bloomberg reported. "Given the Fed's mandate, 25 was the way to go," said James Padinha, economic strategist at Natexis Bleichroeder. "Fifty basis points would have lent the impression of panic and a 'last gasp' attempt. Twenty-five says 'We think this is going to be OK, and if we get more disappointing data we can turn around and do one, two or three more cuts.'" Maybe so. But the Fed had so raised expectations for a 50-basis-point cut -- and perhaps accompanying statements about unusual policy actions it was contemplating to combat deflation -- that 25 basis points proved disappointing. At the every least, it provided a ready-made excuse for some selling after robust rallies in both equities and Treasuries.